FIFO, LIFO AND WAC METHODS

How accounting’s choice could impact financial performance

1
Impact of stock evaluation method
Quantity Unit Cost (€) Total cost

Opening
merchandise 100 100
inventory
Merchandise
60 80 Selling price per unit = 95 €
purchased

Available inventory*

Merchandise sold

Ending merchandise
40
inventory

2
 Components inventory: FIFO

Quantity Unit Cost (€) Total cost

Opening inventory 100 100 10,000
Purchase cost 60 80 4,800
Merchandise sold
From opening inventory first 100 100 10,000
From purchase 20 80 1,600
Total 120 11,600
Ending inventory 40 80 3,200
 Weighted Average (Unit) Cost (WAC)
Quantity Unit Cost (€) Total cost

Opening merchandise inventory 100 100 €10,000

Cost of merchandise purchased 60 80 €4,800

WAC = 14,800 /160 = 92.5
Available inventory* 160 92.5 €14,800

Cost of Merchandise sold 120 92.5 €11,100

Ending merchandise inventory 40 92.5 €3,700

 Components inventory: LIFO
Quantity Unit Cost (€) Total cost
Opening inventory 100 100 10,000
Purchase cost 60 80 4,800
Merchandise sold
From purchase first 60 80 4,800
From opening inventory 60 100 6,000
Total 120 10,800
Ending inventory 40 100 4,000
Comparison of the three methods

FIFO WAC LIFO

Year N
Revenue 12 000 12 000 12 000
COGS 11 600 11 100 10 800
Profit N 400 900 1 200
Year N+1
Value merchandise in
3 200 3 700 4 000
inventory
Revenue 4 000 4 000 4 000
Profit N+1 800 300 -
total over 2 years 1 200 1 200 1 200

6
AN OTHER EXPLORATION OF PROFIT
An micro economic approach
Variable vs fixed costs

Variable costs are any costs that a company incurs that are associated with the number of
goods or services it produces. A company's variable costs increase and decrease with its
production volume. When production volume goes up, the variable costs increase. But if
the volume goes down, the variable costs follow suit.

Fixed costs remain regardless of whether goods or services are produced or not. Thus, a
company cannot avoid fixed costs. As such, a company's fixed costs don't vary with the
volume of production. Their mainly related to the structure of the company (overheads,
investments…)
Behavior of variable costs

THEORIE REALITY

Costs
Costs

Volume of activity Volume of activity

Behavior of fixed costs

THEORIE REALITY
Costs

Costs
Volume of activity Volume of activity
Examples of variable and fixed costs
Beta Sales Company
Contribution Format Income Statement

For Year Ended December 31, 201X

Sales $ 462,452
Less Variable Costs:
Cost of Goods Sold $ 230,934
Sales Commissions $ 58,852
Delivery Charges $ 13,984
Total Variable Costs $ 303,770
Contribution Margin $ 158,682 34%
Labour Less: Fixed Costs:
costs Advertising $ 1,850
Depreciation $ 13,250
Insurance $ 5,400
Payroll Taxes $ 8,200
Rent $ 9,600
Utilities $ 17,801
Wages $ 40,000
Total Fixed Costs $ 96,101
Net Operating Income $ 62,581
Managing fixed and variable costs
evolution
Fixed costs are not so fixe Variable cost varie much more than expected

Variable costs per unit

Where management controler must control

Various strategies to steer the costs : standardisation, spare decision of investment from operational action,
budget and variance analyse…
 Common-size income statement
All in function of sales revenue

In % of In % of
revenue revenue
In N in N+1
Sales revenue 100% 100%
Explain the evolution
Variable costs 80% 78% of profit ?
Contribution margin 20% 22%
Fixed costs
15% 17%

Operating profit or EBIT 5% 5%

13
 Common-size income statement
All in function of sales revenue

In % of In % of
revenue revenue in Possible explanations of Contribution
In N N+1 Margin performance :
- Decrease in unit COGS (or other
Sales revenue 100% 100% Variable Costs),
Variable costs 80% 78% - Increase in selling price higher than
increase in unit COGS,
Contribution margin 20% 22% - Decrease in unit COGS higher than
decrease in selling price
Fixed costs
15% 17% - Or increase in selling price without
change in unit COGS
Operating profit or EBIT 5% 5%

Fixed costs increased higher revenue  diseconomy of sales :

- Due to a volume increase, a change in Fixed costs happened but this volume growth is below the new production capacity
- An anticipation in future investment generate a temporary decrease in performance

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Case study

 Macro Hard
Break even point

 The lever of activity for which the variable margin matches the fixed
costs is the break even point  the volume of activity requiered for a
profit egal to 0.

Solving the equation  Sales – variable expenses – fixed expenses = 0

Per unit
 (Unit sales price x number of units) – (unit variable costs x numbers of units) – fixed expenses = 0
 Unit contribution margin x number of units – fixed expenses = 0
 Break even point = fixed expenses / unit contribution margin

Global
 Rate of contibution margin x Turnover – fixed expenses = 0
 Break even point = fixed expenses / rate of contribution margin
Break even point – graphic presentation
Costs structure: case PNG

 PNG electric company manufactures a number of electric products. Rechargeable

light is one of the PNG’s products that sells for $180/unit. Total fixed expenses
related to rechargeable electric light are $270,000 per month and variable expenses
involved in manufacturing this product are $126 per unit. Monthly sales are 8,000
rechargeable lights.
 Required:
 Compute break-even point of the company in dollars and units.
 According to a research conducted by sales department, a 10% reduction in sales price will result
in 25% increase in unit sale. Prepare two income statements in contribution margin format, one
using the current price and one using proposed price (10% below the old sales price).
 If we carry on with this new price, compute the number of rechargeable lights to be sold to earn a
net operating income equivalent to the previous one.
PNG electric: BE point

Computation of break-even point:

 Break even point in units:
 Fixed expenses / Contribution margin per unit
 270,000 / 54 = 5000 units
Contribution margin = $180 – $126 = $ 54

 Break-even point in dollars:

 5000 units × $180 = $900,000
 PNG Solution
Current price
unit volume Total
Sales 180 8000 1 440 000
Variable costs 126 8000 1 008 000 Proposed price
Fixed costs 270 000 unit volume Total
Profit 162 000 Sales 162 10 000 1 620 000
Variable costs 126 10 000 1 260 000
Fixed costs 270 000
Profit 90 000

20
PNG electric: target profit and
commercial goals
Target profit analysis:
We can compute the target income using following
equation
Sales = Variable expenses + Fixed expenses + Profit
$162Q = $126Q + 270,000 + $162,000
$162Q – $126Q = $432,000
$36Q = $432,000
Q = $432, 000 / $36
Q = 12,000 Units
Strategy to manage BE point

Strategy Economic effect Process involved

Raise prices Marketing and commercial
Lowered variable Raising contribution margin Production ==> improve productivity
cost per unit
Lowered fixed costs Production ==> Change the
Reducing BE point and volume of production system
Switch fixed costs to production to be profitable Out sourcing
variable costs
Raise volume of Marketing and commercia ==> raise
production price and perception of quality
Developing economies of scale
Cross sell - customer Marketing and commercial ==>
loyalty
Break even point and strategy:
analyzing performance conditions
N N+1 N+2 N+3 N+4
Revenu 1,121,345 1,546,789 2,123,456 2,546,789 3,270,521
Sales volume 11,213 16,453 24,231 29,656 39,467
Variable costs 675,467 990,456 1,450,678 1,864,568 2,585,980
Fixed costs 234,567 323,498 425,698 423,456 423,456

Q:
• Analyse the profit of this company
• Express the situation
• What do you think of the risks for this Cie
Profit and risk profil
N N+1 N+2 N+3 N+4
Revenu 1 121 345 1 546 789 2 123 456 2 546 789 3 270 521
Sales volume 11 213 16 453 24 231 29 656 39 467
Variable costs 675 467 990 456 1 450 678 1 864 568 2 585 980
Fixed costs 234 567 323 498 425 698 423 456 423 456

Contribution margin 445 878 556 333 672 778 682 221 684 541
Contribution margin rate 40% 36% 32% 27% 21%

Profit 211 311 232 835 247 080 258 765 261 085
Profit rate 19% 15% 12% 10% 8%

BEP 589 916 899 431 1 343 610 1 580 797 2 023 139
Safety margin 531 429 647 358 779 846 965 992 1 247 382
Safety index 47% 42% 37% 38% 38%
Cost structure evolution and risks

 Safety margin = Revenue – Break even point

 Safety index = Safety margin / Revenue

Case securit car
Securit car - solution
Y0 Y1 internal Y1 outsourced
Evolution Evolution
Revenue 55 345 15% 60 464 15% 60 464
Variable costs
Raw materials 15 000 -3% 16 733
30 665
Marketing 2 000 10% 2 530
Variable costs 17 000 19 263
Contribution margin 38 345 41 202 29 799
Contribution margin rate 69,28% 68,14% -20% 49%
Fixed costs
Administrative 5 000 5 000 -25% 3 750
Marketing 7 500 10% 8 250 10% 8 250
Research and development 10 000 20% 12 000 20% 12 000
Depreciation 5 000 1 000 6 000 -25% 3 750
Total Fixed costs 27 500 31 250 27 750
EBIT 10 845 9 952 2 049
20% 16% 3%
BE POINT 39 692 45 860 56 307
Safety margin 15 653 14 605 4 158
Safety index 28,28% 24,15% 6,88%
Operational lever

Explain the impact of revenu on operational profit

OL = Contribution margin / Profit

∆ Profit (in %) = ∆ Revenu (in %) x OL

https://www.investopedia.com/terms/o/operati
ngleverage.asp
 Operational lever (LO) : exemple
Produit A B
Revenu 100 100
VC 40 60
Contribution margin 60 40
M% 60% 40%
Fixed cost 40 20
Profit 20 20
LO = ……. …..
Profit = 0 Revenu * =
Profit = 40 Revenu * =
 Operational lever (LO) : exemple
Produit A B
Revenu 100 100
VC 40 60
Contribution margin 60 40
M% 60% 40%
Fixed cost 40 20
Profit 20 20
LO = 3 2
Profit = 0 Revenu * = 66,67 50
Profit = 40 Revenu * = 133,33 150
 Relation strategy / cost structure

Contribution
margin rate
Differencitation
Niche strategy strategy
High

Low Epuration strategy Volume strategy

Low High FC
Merci de votre attention.

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